Analysis of Short
Run Cost of Production:
Definition
of Short Run:
Short run is a period of time over which at least one factor
must remain fixed. For most of the firms, the fixed resource or
factors which cannot be increased to meet the rising demand of
the good is capital i.e., plant and machinery.
Short run,
then, is a period of time over which output can be changed by
adjusting the quantities of resources such as labor, raw
material, fuel but the size or scale of the firm remains fixed.
Definition
of Long Run:
In the
long run there is no fixed resource. All the factors of
production are variable. The length of the long run differs from
industry to industry depending upon the nature of production.
For
example, a balloon making firm can change the size of firm
more quickly than a car manufacturing firm.
Categories/Types
of
Costs in the Short Run:
The total
cost of a firm in the short run is divided into two categories
(1) Fixed cost and (2) Variable cost. The two types of economic
costs are now discussed in brief.
(1) Total
Fixed Cost (TFC):
Total
fixed cost
occur only in the short run. Total Fixed cost as the name
implies is the cost of the firm's fixed resources, Fixed cost
remains the same in the short run regardless of how many units
of output are produced. We can say that fixed cost of a firm is
that part of total cost which does not vary with changes in
output per period of time. Fixed cost is to be incurred even if
the output of the firm is zero.
For
example, the firm's resources which remain fixed in the
short run are building, machinery and even staff employed on
contract for work over a particular period.
(2) Total
Variable Cost (TVC):
Total
variable cost
as the name signifies is the cost of variable resources of a
firm that are used along with the firm's existing fixed
resources. Total variable cost is linked with the level of
output. When output is zero, variable cost is zero. When output
increases, variable cost also increases and it decreases with
the decrease in output. So any resource which can be varied to
increase or decrease with the rate of output is variable cost of
the firm.
For
example, wages paid to the labor engaged in production,
prices of raw material which a firm. incurs on the production of
output are variable costs. A firm can reduce its variable cost
by lowering output but it cannot decrease its fixed cost. These
expenses remain fixed in the short run. In the long run there
are no fixed resources. All resources are variable. Therefore, a
firm has no fixed cost in the long run. All long run costs are
variable costs.
(3) Total
Cost (TC):
Total cost
is the sum of fixed cost and variable cost incurred at each
level of output. Total cost of production of a firm equals its
fixed cost plus its:
Formula:
TC = TFC
+ TVC
Where:
TC = Total
cost.
TFC = Total fixed cost.
TVC = Total variable cost.
Explanation:
Short run
costs of a firm is now explained with the help of a schedule and
diagrams.
Schedule:
(in Dollars)
|
Units of Output (in Hundred) |
Total Fixed Cost |
Total Variable Cost |
Total Cost |
|
0 |
1000 |
0 |
1000 |
|
1 |
1000 |
60 |
1060 |
|
2 |
1000 |
100 |
1100 |
|
3 |
1000 |
150 |
1150 |
|
4 |
1000 |
200 |
1200 |
|
5 |
1000 |
400 |
1400 |
|
6 |
1000 |
700 |
1700 |
|
7 |
1000 |
1100 |
2100 |
The short
run cost data of the firm shows that total fixed cost TFC
(column 2) remains constant at $1000/- regardless of the level
of output.
The column 3 indicates variable cost which is
associated with the level of output. Total variable cost is zero
when production is zero. Total variable cost increases with the
increase in output. The variable does not increase by the same
amount for each increase in output. Initially the variable cost
increases by a smaller amount up to 3rd unit of
output and after which it increases by larger amounts.
Column
(4) indicates total cost which is the sum of TFC + TVC. The
total cost increases for each level of output. The rise in total
cost is more sharp after the 4th level of output.
The concepts of costs, i.e., (1) total fixed cost (2) total
variable cost and (3) total cost can be illustrated graphically.
(i) Total
Fixed Cost Curve/Diagram:
In this
diagram (13.1) the total fixed cost of a firm is assumed to be
$1000 at various levels of output. It remains the same even if
the firm's output is zero.
(ii) Total
Variable Cost Curve/Diagram:
In the
figure (13.2), the total variable cost curve (TVC) increases
with the higher level of output. It starts from the origin. Then
increases at a diminishing rate up to the 4th units of output.
It then begins to rise at an increasing rate.
Total Cost Curve Curve/Diagram:
In the
figure (13.3), total cost curve which is the sum of the total
fixed cost and variable cost at various levels of output has
nearly the same shape. The difference between the two is by only
a fixed amount of $1,000. The total variable cost curve and the
total cost curve begin to rise more rapidly as production is
increased. The reason for this is that after a certain
output, the
business has passed its most efficient use of its fixed costs
machinery, building etc., and its diminishing return begins to
set in.
Analytical
Importance of Fixed and Variable Costs:
In the time
of distinction between fixed cost and variable cost is a matter
of degree, it all depends upon the contracts of a firm and .the
period of time under consideration.
For example,
if a firm makes contract with the labor for a certain period,
then the firm has to bear the cost of the labor irrespective of
the total produce. Under such conditions, the wages paid to the
labor will be classified as fixed cost and not variable cost, as
discussed under the heading of variable cost. Secondly, when the
period of time is short, the distinction between fixed cost and
variable cost can be made rigid but not in a longer period of
time all fixed costs change into variable cost in the long run.
Relevant Articles:
|
